Paper advises expert panel to evaluate, recommend financial stability reforms (including those to deal with leveraged lending challenges)

Congress should evaluate through an expert commission the effectiveness of post-crisis regulatory reforms it adopted in 2010, including whether federal regulatory authorities have sufficient flexibility to react to new vulnerabilities, according to a paper released Wednesday at a Federal Reserve conference.

The paper – Financial Stability Considerations and Monetary Policy? – was delivered at the Fed’s Conference on Monetary Policy Strategy, Tools, and Communication Practices, a two-day event held in Chicago, which ended Wednesday. The conference was part of a series of events the Fed is hosting to explore its policies and strategies surrounding monetary policy decisions.

The paper on financial stability – which the paper shows was coauthored by Anil K. Kashyap and Caspar Siegert, of the University of Chicago and Bank of England, respectively – is also notable because it also drew, the authors acknowledged, on conversations with former Fed official Nellie Liang. Liang herself was a nominee last year to fill an open seat on the Federal Reserve Board; she withdrew her name from consideration early this year after the Senate failed to consider the nomination (including with a confirmation hearing).

Liang, now at the Brookings Institution in Washington, moderated the discussion panel – which included the authors – at the conference.

In their conclusions, the authors said that rolling back some aspects of the Dodd-Frank Wall Reform and Consumer Protection Act of 2010 (Dodd-Frank) was appropriate, in that the law was passed in the immediate wake of the financial crisis. “However, it seems equally appropriate to step back and ask whether there are financial stability risks that Dodd Frank did not fully mitigate,” the paper states.

The paper asserts that “there are two gaps in the current macroprudential landscape in the U.S.” The first, it states, is the absence of any regulator having sufficient authority to extend the regulatory perimeter to account for risks that continue to appear outside the banking system.

“The fact that the Federal Reserve identifies leverage lending as a source for concern and that a large fraction of leveraged lending exposures are held by investors that reside outside of the regulatory perimeter is a great example of why authorities need the flexibility to adjust the regulatory perimeter,” the paper states. “A second gap is the absence of tools that regulators have for dealing with borrower resilience.”

The authors suggested that Congress establish an expert commission to review whether there are areas in which post-crisis reforms have unnecessarily restricted the provision of financial services to the real economy, and also whether there are important regulatory gaps in the current architecture.

The commission, the authors suggested, could survey international best practices for how financial stability risks have been addressed elsewhere and consider what might be suitable in the U.S. “It could also draw on detailed work that the Financial Stability Board has been doing at an international level to evaluate the effectiveness of post-crisis reforms and to identify new, emerging vulnerabilities.”

The authors acknowledge that “the appetite” to make far-reaching changes to the U.S. regulatory framework may be limited, but they said “we believe our analysis suggests that there is a strong case for examining whether the current regulatory framework gives authorities enough flexibility to address emerging risks.”

The authors pointed to the congressionally established, bipartisan U.S. Commission on Evidence Based Policymaking as a model for the approach. According to the pair, many of the commission’s recommendations were included in the Foundations for Evidence-Based Policymaking Act of 2018 that became law.

“One further advantage of starting with a commission to address these issues is that it allows experts to agree on a small set of tangible changes before putting its proposals to Congress,” Kashyap and Siegert wrote. “This would help focus the discussion on holes in the macroprudential toolkit that a group of experts identifies as most relevant, rather than debating a full rewrite of the FSOC’s [Financial Stability Oversight Council] mandate or Federal Reserve’s responsibilities.”

Financial Stability Considerations and Monetary Policy?

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